The properties that Alexandria Real Estate Equities (ARE -0.13%) owns are very complex, but its business model is actually pretty simple. That model has also proven to be very robust over time, allowing the real estate investment trust (REIT) with a focus on medical research properties to increase its dividend annually for more than a decade. Here's why Alexandria's dividend is highly likely to keep growing.
A basic business
As a REIT Alexandria's goal is to own the most desirable properties in the most desirable markets. As the old saying goes, it's about location, location, location. To achieve this, management focuses on what it calls a "cluster model."
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To put it simply, medical research is usually centered around main hubs and that's where the REIT builds out its property holdings, generally consisting of multiple assets in each region. The core focus of the company today is on New York City, Boston, the San Francisco Bay area, San Diego, Seattle, Maryland, and the research triangle around Duke University, University of North Carolina at Chapel Hill, and North Carolina State University.
All in, Alexandria has 1,000 tenants spread across its roughly 75 million square feet worth of property. Occupancy is a solid 94.3%. But this isn't a situation where management buys an asset and just sits on it. The REIT is an active manager, buying, selling, developing, and redeveloping properties. For example, through the first 10 months of 2022, Alexandria bought 41 properties worth a total of $2.65 billion. That's roughly in the middle of the company's full-year guidance for acquisitions.
Meanwhile, it sold nine properties worth roughly $2.2 billion through October, again about the midpoint of guidance. These are assets that management believed were fully valued and ripe for harvesting. But take a moment to compare the purchases and sales, noting that the cash it generated from selling assets is very close to the cash it paid for new assets. Management is basically looking to self fund as much as possible, reducing the need to utilize dilutive stock sales and debt issuance. With an investment-grade-rated balance sheet, Alexandria probably doesn't need to worry too much about access to capital markets, but successful active portfolio management is a shareholder-friendly thing to see.
The key to the acquisitions, meanwhile, is that they provide the REIT with an opportunity to increase the value of the properties. That can come from things as dramatic as tearing down what's there and building a new medical research asset from the ground up to simply redeveloping the existing asset so it is more desirable to tenants. Both lead to long-term growth in rents and property values.
Room for more
Simply put, Alexandria is doing exactly what a dividend growth investor would like to see it do. Historically, as its investments bear fruit, the company's financial results allow the REIT to pay a rising dividend. Over the past decade, the dividend increased at a compound annual rate of around 8%, which is pretty generous for a REIT. To be fair, the dividend yield is modest at 3.3%, which is just a touch below the 3.5% average for REITs, using the Vanguard Real Estate Index ETF as a proxy. However, that's toward the high end of Alexandria's yield range over the past decade, so the REIT seems attractively priced right now. The big story, however, is dividend growth, which is what most investors will be searching for here.
On that score, the board of directors recently increased the quarterly dividend to $1.21 per share, which will leave the full-year 2022 dividend roughly 5% higher than the payment made in 2021. The company's third-quarter funds from operations (FFO), meanwhile, was $2.13 per share. Divide the dividend by the FFO and you get an FFO payout ratio of roughly 57%. That's pretty low and means there's a lot of room for adversity before the dividend would be at risk or, conversely, ample room for further dividend growth.
To be fair, office properties generally require more capital investment than other property types. (And redevelopment and development projects always carry execution risk, especially in an environment with rising inflation.) So investors shouldn't go in thinking that Alexandria could increase that ratio up to 80% via a huge one-time dividend increase. The real takeaway is that the payout ratio is not likely to be a hindrance to future dividend hikes. The investment-grade-rated balance sheet is another positive since it signifies that the REIT has the strong financial foundation needed to support its business and more dividend growth.
More of the same
Alexandria has the dominoes lined up for the kind of strong ongoing business results that lead to dividend growth. It has the financial foundation to support higher dividends, as well. All in, there's no reason to suspect that the REIT's future will be any different than its past. And that means dividend growth investors should be very pleased with what they see here, including the historically high yield.
